To celebrate one year of the book Invest Your Way, Mark and Shani tackle listener questions on some of the biggest decisions investors face, from calculating the true cost of everyday spending to working out how much risk to take in retirement.

The first is an expensive question - how much could owning a car cost you in retirement savings? They explore the long term opportunity cost of car ownership, using an illustrative example to show where you end up by investing the amount.

They also received a question on retirement income. If your portfolio generates enough dividends to cover your living expenses, do you still need to follow the 4% withdrawal rule? Shani and Mark unpack the risks the rule is designed to address, why living off dividends changes the equation, and the trade offs investors need to consider when income fluctuates.

Finally, they explore what happens when you get ahead of your financial plan. Should you move into more defensive investments, pay off your mortgage or set a more ambitious goal? The answer requires you to consider more than market returns, but also changing priorities, the risk of extrapolating recent performance into the future and how much financial security you need to feel comfortable.

You can find the transcript below:

Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances, or needs.

Mark LaMonica: Shani, it’s been one year since we published our book. We’ve been talking about this on recent episodes, but that’s the book. It’s been one year. And we just want to say that we are incredibly grateful for all the support we’ve received, anyone who’s bought the book, anyone who’s left a review, so we’re just really appreciative.

Jayamanne: Yeah, very much so. Thank you, everybody, for the continued support.

LaMonica: And we have a competition.

Jayamanne: We do.

LaMonica: Now Shani’s going to correct me because I’ll probably get the terms wrong in this competition. But anyone who has read the book or wants to buy the book and read it. The competition is we’re just asking people to put a review in. So you can put the review in on Audible if you’ve listened to the audio book. You can put it on Amazon. You can put it on Goodreads.

Jayamanne: Anywhere that you’ve purchased a book, really.

LaMonica: Exactly. So somebody putting a review on. It doesn’t even have to be good, although…

Jayamanne: We’d prefer good…

LaMonica: We’d prefer the good reviews. Then email it to me, and we’re going to randomly draw somebody’s name. And there could be millions of reviews. So anyway, you probably have a pretty good chance of winning if you do this. And you have two choices.

Choice one, we will give you a $300 gift certificate to take yourself out to lunch or dinner or whatever. Or if you happen to be in Sydney, you can go out to lunch with us. But also if you’re in Sydney, you can just take the gift certificate.

Jayamanne: Yeah, you can choose one or the other. Or you can just pretend you’re not in Sydney to save our feelings.

LaMonica: Nobody saves our feelings.

Jayamanne: So I’m into lunch with both of us. I know which one I’d choose.

LaMonica: Yourself.

Jayamanne: No, in terms of the gift card or lunch.

LaMonica: Okay, yeah. No, me too. But anyway, that’s our competition. So send me an email, write a review. We’d appreciate it. And a big thank you to Daisy, who left a review. It’s a very kind review. So I’m going to read it and people can use this as a template.

The best book I’ve read on investing so far. If you already have a good grasp of budgeting and the basics of investing and are ready to put it all together into an investing strategy, this is the book for you. Filled with fantastic studies and behavioral tips to help you figure out your own strategy. Spoiler alert, invest passively for the long term and ignore the noise.

Jayamanne: That is a very kind review.

LaMonica: It is. And I like the end part of that because that’s basically what you do. So she just ignored all my income investing stuff. But anyway, thank you, Daisy, for the review. And you want to say something to this guy, Simon that you run into on the street.

Jayamanne: That sounds very strange. But Simon is a podcast listener, and big shout out to Simon. He’s a listener and he’s a very nice guy.

LaMonica: Okay.Well, maybe someday I will meet Simon. But the other thing we’re doing is celebrate the one-year anniversary, and we’re getting into the actual show today. Is as we’ve been saying, we’re going to do a QA show. So a big thank you for everyone who sent in a question.

Jayamanne: And the first question is from Mike. Mike is relatively new to investing and was inspired to focus on investing by his mother. And Mike wants to pass this inspiration on to his grandkids and is thinking about writing an essay to help them out. We both really support that.

LaMonica: That is true.

Jayamanne: We both like writing.

LaMonica: That is true. And the question that Mike asked, it’s related to something that I mentioned in the book, and that’s about how I don’t have a car. So Mike asked, how much does car ownership cost someone in terms of reduced retirement savings over their working life? It must be a staggering amount. So Mike is right. It is a staggering amount.

And there’s lots of different things that we can do, obviously, to translate this into retirement savings. But according to the Australian Automobile Association, the average cost nationwide to own and run a car in Australia is $23,389 to $24,484 per year, which is strangely exact. And it’s also like a very small range. But anyway, we believe the good people at the AAA. And that is a lot. It generally equates to about 15% of an average household’s income. Now, those costs are everything. So that includes petrol, loan payments, for example, make up 47% of that number. The petrol costs are 21%, insurance is 10%. So it’s a lot of different things, but it is a big number.

Jayamanne: But I think there are a few larger lessons that we’ve tried to stress in the book and on this podcast. And the first is simply to be deliberate with your spending, which is very different to not spending. There are many people out there that need a car, and of course, those people should buy a car. There are also lots of people out there, they just want a car, and there is nothing wrong with that. The whole point of building financial independence is to make your life better and easier. That means directing the limited amount of resources that you do have to places that bring us joy or utility. So just be deliberate about your decisions.

LaMonica: The second lesson is thinking about the lifetime cost of anything you buy and not just the upfront cost. So one of the reasons that I always talk about why I love dividend paying shares is because I think about that future income stream that I’m getting out of them. So if I invest enough, since we were talking about lunch earlier, Shani, if I invest enough to pay for even a lunch a year, I think, okay, well, you know, potentially that’s a lunch for the rest of my life, even if it’s only one a year. And I think about that and kind of chipping things away.

And, if we look at that AAA data, it’s the exact opposite what they’re showing with cars. And these are not just one off purchases. Cars are costing people a lot of money long after that purchase decision is made. So particularly when you’re deciding between different options, different types of cars, maybe, and those lifetime costs, just think about what that could potentially do to your financial flexibility. So I did quickly run the numbers. So let’s say you pay $23,000 a year for a car for 20 years. If you invest that instead, you earn a 7% return. It’s $950,000. So there’s obviously a lot of variables we can play around with to get to that number.

Jayamanne: And you can buy a very nice car with $950,000.

LaMonica: That is true. I don’t know how much cars cost because I’ve not had one in a while. And Shani likes to joke about this because I thought cars cost more than they did.

Jayamanne: Mark thinks that all cars cost 100,000?

LaMonica: I didn’t know. How would I know how much a car costs? I don’t have a car.

Jayamanne: I don’t know. It’s like when you ask the Prime Minister how much is a loaf of bread or how much is milk, and they’re very out of touch.

LaMonica: Okay, so I’m out of touch on what cars cost. That is uh that’s me. Why don’t we get to our next question, Shani?

Jayamanne: So our next question is from Tim. And this question is right up your alley Mark. Tim asks if the 4% rule still applies if you’re able to fully live off dividends from your portfolio.

LaMonica: That’s a very good question. So I don’t know how much a car costs, but I do know how to answer this question. So before I get to the answer, Shani, do you want to give an overview of what the 4% rule is?

Jayamanne: So the 4% rule is supposed to help retirees with the foundational goal of any retirement, which is don’t run out of money. How quickly you run out of money depends on the interplay between several factors, including your withdrawal rate, inflation, and the order and magnitude of your returns. And the 4% rule is a withdrawal rate that a financial planner named Bill Bengen came up with in the 1990s, which is supposed to represent a safe withdrawal rate over a 30-year period using historic return and inflation data. The other key part of the 4% rule is after the first year of spending, which is 4% of your portfolio, you increase the dollar amount of spending by inflation each year of your retirement. There are also assumptions about asset allocation.

LaMonica: All right, so let’s contrast this with just spending dividends. So the 4% rule, the issue that it’s trying to protect you against is especially early in retirement, having to sell off your portfolio if the market drops a lot. Now, by selling and taking that money out, you have less money invested when the market hopefully recovers. Now, that’s sequencing risk, and that is one of the biggest risks associated with retirement. Now, if you are living off of dividends, none of this happens because you are not selling anything. So even if the market plunges, you just simply collect your dividends. And also you’re not going to run out of money because in theory, you aren’t spending your portfolio and the income it generates can just last forever.

Jayamanne: But there are a couple of caveats to this. Since you are just living off your dividends, you will have to adjust your spending if the dividends fluctuate. That could mean not keeping up with inflation or even have your spending cut if dividends do drop. So you need to pick the right investments.

LaMonica: And in the real world, if this was the strategy that you were pursuing, I would be careful to keep a cash buffer and also set a budget where you potentially spend less than your baseline dividend income. So both of these are buffers, right? The cash and spending less than the dividends. And that can protect you in case those dividends fluctuate, or there are widespread cuts like we saw during the pandemic.

Jayamanne: All right. So let’s move on to our next question, and it’s come from Sharon.

LaMonica: Okay. And this is a good question. I thought about this. Shani was on leave last week and you sent me a text message saying you were not coming back to work if you won the lottery that night.

Jayamanne: Yeah. I mean, would you?

LaMonica: Yes, I would. Because of my commitment to the podcast.

Jayamanne: That’s fair enough.

LaMonica: Apparently, only I have that.

Jayamanne: But let’s move on to what Sharon asks. So what happens if by virtue of a higher than expected income or above expected returns, or an unanticipated windfall, or a combination of all three, one finds oneself in the happy position of being substantially past the goal position 10 years earlier than expected. And one argument would be to thank your lucky stars, retire immediately, move a very substantial portion of your portfolio to a defensive position, such as a high interest savings account and or a latter term deposit and kick back and enjoy it. In doing this, you accept a much lower rate of return than you’re accustomed to. But the argument goes, that doesn’t matter because you’re past your goal and why should you take any risk that you don’t need to?

LaMonica: Okay, it’s a long but very good question. And I think there are a lot of ways to think about this. So I think you know, one of the foundations of this podcast and one of the foundational lessons we try to preach on this podcast is we encourage investors to set goals. If you don’t have a vision of where you want to get, it’s really, really difficult to figure out a plan to actually get there. So there are multiple facets of any plan that you come up with. It should inform your investment strategy, but it also informs how much money you save. And for many people, especially people with a long time to their goal, that is the lever that has the biggest influence, just saving money, something that you talk about a lot, Shani. But as Sharon indicated, there can be all sorts of changes that take place in life. And as you age, maybe what you want out of life can change. There could be setbacks. There could be windfalls, like what Sharon was talking about.

That can happen if you have higher than expected returns for a while, or it could be something like an inheritance or a promotion at work or a pay rise. And I actually wrote in a recent article, an evolving goal is better than no goal at all. So even though knowing all this stuff will happen in life, no matter what age you are, we encourage you to set a goal.

Jayamanne: And this is something that I wrote about in the book when I first started working and investing, my goals were pretty straightforward. I wanted to get myself into a position where I could independently pay for the basics of life. And as my career progressed, I started to have bigger dreams and expanded the possibilities of what I wanted out of life. And I expect that to continue as life goes on.

LaMonica: Especially if you win the lottery. So let’s dig into Sharon’s question a little bit. So if your goal doesn’t change and you make either faster progress towards your goal, and that means you save more or you get a higher return, then your expected rate of return from that point on will be lower. So that naturally will just go down.

Jayamanne: So let’s map this out mathematically. Let’s say you set a goal with 20 years to go and you need a 7% return to get to your goal. 10 years later, you’ve earned a 10% return with a decade to go until your goal, if you earn that same 7% a year return you’ve originally outlined, you would exceed your goal on a dollar basis by just about 32%. You have two options now. The return you need now to achieve your original goal is no longer 7%. It’s just above 4%.

LaMonica: And the way that you would invest, as Sharon wrote in her question, the way that you would invest to get a 4% return is very different than if you’re trying to get a 7% return. You could significantly increase the amount that you allocate to defensive assets. For instance, right now, a 10-year Australian government bond is yielding around 5.3%. That means you could exceed that new required rate of return simply by investing your entire portfolio in a 10-year government bond, and you could just ignore the share market completely.

Jayamanne: So as Sharon pointed out, the question is do you set a higher goal for the next decade and get more conservative? Or do you continue your current investment strategy designed to achieve a 7% return?

LaMonica: And like many things with personal finance, there is no right answer for this question. People will, of course, have to decide for themselves. But we do have a couple of tips that we can provide to help frame this decision. So the first is the cyclical nature of returns. So we’ve gone through a period of historically high returns, which exceeded the long-term average from the share market. So it does make sense that at some point we will go through a period of historically lower returns to get back to that average. Now that could happen with a bear market where the market falls a lot. It could happen over a longer stretch of time where returns are just lower.

But either way, it is likely at some point we are going to experience a more challenging return environment than we’ve been through. The other thing to note is that the market is trading at a high valuation right now. High valuation means future returns should be lower. Your expectations should be lower. You’re paying more for dollar of earnings now, you’re paying more for future growth. It means that returns will be lower in the future.

Jayamanne: The other thing to consider is the danger of constantly moving the goalposts based on short-term market performance. Investors suffer from recency bias where whatever has recently happened, which is good or bad, is extrapolated out into the future. So overall, we think some balance is required. As good things happen and your expectations for your life evolve, it is just natural to adjust your goal.

LaMonica: And to do that in a pragmatic way, so your goal remains realistic. And there is no harm in increasing your financial security and resilience along the way. So that could be building up cash levels a bit if you find yourself ahead of your goals. It could be adjusting your asset allocation to get slightly more conservative, or you can look within an asset class and move into safer investments within that asset class. It could mean paying off your mortgage, even if you think you can get a higher return from the share market.

It has been a while since the last major bear market, but it will happen again at some point. There will always be setbacks in life, like unexpected expenses. Investing isn’t always about trying to get the highest return possible. It’s about building resilience into your finances so that you can rest better at night. So just make sure that you take a holistic view of your finances and how they actually make your life better and adjust based on that.

Jayamanne: And that’s the last question that we have time for today in this episode. But we do plan to do QA episodes in the future. So please keep those questions coming.

LaMonica: And we did both want to thank everybody once again for their support of the book, support of the podcast, especially Simon, and the people that wrote in with questions. So when we wrote this book, we wanted to create a different book about money, one that looked holistically at all the structures that are in place that guide decision making so investors can get what they want out of life. For anyone who hasn’t read it, you can pick up copy on Amazon, Booktopia, still in bookstores. And we’ve been nominated by the Australian Business Book Awards for Book of the Year in the personal finance category, which is exciting, Shani.

Jayamanne: It is very exciting.

LaMonica: It’s basically like the Nobel Prize in literature, I think.

Jayamanne: No comment.

LaMonica: Yes, I just have to research a little more. But anyway, thank you guys very much for listening.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australia proprietary limited and/or Morningstar Research Limited without reference to your financial objectives, situations, or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact the financial advisor.)

Invest Your Way

A message from Mark and Shani

For the past five years, we’ve released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar.

We’ve shared our journeys with you, and you’ve shared back. We’ve listened to what you’re after and created a companion for your investing journey – Invest Your Way. Invest Your Way is a book that focuses on the investor, instead of the investments. It is a guide to successful investing, with actionable insights and practical applications.

If anyone would like to support this project you can buy the book now. Thanks in advance!

Purchase from Amazon

Purchase from Booktopia